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Morrison - strong sales but Covid costs weigh on profits

Sophie Lund-Yates, Equity Analyst | 10 September 2020 | A A A
Morrison - strong sales but Covid costs weigh on profits

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Morrison (Wm) Supermarkets Ordinary 10p

Sell: 174.45 | Buy: 174.60 | Change 2.00 (1.17%)
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Like-for-like sales excluding fuel rose 8.7% in the first half, contributing to an 8.8% rise in total revenue (also excluding fuel) to £7.6bn. The increase reflects a strong performance from retail, especially in the second quarter. However, underlying pre-tax profit fell 25.3% to £148m because of extra costs related to coronavirus, and customer preference for lower-margin products.

Disruption from the pandemic also meant Morrison has reported a cash outflow this half.

The interim dividend of 2.04p per share is up 5.7% on last year. The decision on the special dividend relating to the end of the last financial year, remains deferred because of ongoing uncertainty.

The shares fell 3.6% following the announcement.

View the latest Morrisons share price and how to deal

Our View

The first half of the year has carried the weight of coronavirus disruption. £155m of extra costs associated with an army of extra workers and other coronavirus costs could only be partially offset by the government's business rate relief scheme.

Customers have been stocking up on less profitable tinned and alcoholic goods, which is also hurting profits. Disruption to the status quo, including lower fuel consumption and the decision to help smaller suppliers by paying them more quickly, means nearly £230m of free cash flowed out the business this half.

But a lot of the grocers are in a similar boat. And it's important to look at the bigger picture - we think there are opportunities ahead.

Morrison's online offering is smaller than some of its main rivals', but the huge demand for delivery slots has forced the group to up its digital game. We see this as a catalyst for future growth. Especially as coronavirus has triggered a longer-term shift to online shopping, so if Morrison can use the current situation to lay a bigger, stronger foundation for the online business then this could be a benefit. We have a keen eye on the relationship with Amazon in particular. This won't move the dial yet, but could potentially be lucrative.

Morrison has focused on bulking up its Wholesale supply business in recent times too. The division isn't small fry, with sales expected to reach £1bn soon. The McColl's deal gives the group some exposure to the convenience market too.

The group also owns rather than leases the vast majority of its stores, which helps keep the balance sheet healthy - we're more content with its financial position than for some peers. We also think scrapping the special dividend to protect cash flow is the right thing to do in these uncertain times.

So finances are generally prudently managed, and there are some potentially exciting growth opportunities. But the main focus should still be on store sales for now. Performance was lacklustre before the outbreak. We wonder if Morrison's lower price point makes Aldi and Lidl more of a threat, and in order to stay competitive the group's cutting prices, which increases pressure on already thin margins.

Overall the near to medium term doesn't look too exciting, and we could even see a slowdown in store sales. But we think there could be real growth opportunities ahead for investors prepared to take a long-term view and a bit more risk. Please remember though, there are no guarantees.

Morrison key facts

  • Price/Earnings ratio: 13.7
  • Average Price/Earnings ratio since listing: 14.0
  • Prospective yield: 4.7%

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results

Retail contributed 7.9% to group like-for-like (LFL) sales, following an 11.1% rise in the second quarter. However, retail margins were held back as sales were weighted towards lower-margin tinned goods, alcohol and online.

Growth in Morrison's online and home delivery services (which now include: Morrisons.com store pick, food boxes, doorstep, 'Morrisons on Amazon' and Deliveroo) was "very substantial", and capacity in these areas has grown five-fold.

Wholesale LFLs grew a more modest 0.8%. The group now supplies 1,300 convenience stores and is close to achieving its goal of £1bn in annualised Wholesale sales. Morrison also announced a new bulk-wholesale delivery service, and have started to supply local councils, care homes and some charities.

Coronavirus related costs reached £155m, including higher payroll expenses. However, this was partially offset by the government's business rate relief, meaning the net cost to the business was £62m.

Four new stores opened in the first half, and a further three are expected to open in the second half. Store refits were mostly paused because of the disruption, but 25 "fresh look" projects are in the pipeline for the second half.

There was a free cash outflow of £228m, compared to an inflow of £244m last year. The decline reflects much lower fuel sales and fuel prices, as well as faster payments to some suppliers, and investment in improving stock availability during the disruption. Net debt (including leases) was £2.8bn, up from £2.5bn at the end of last year.

Morrison expects improved full year free cash flow, net debt and underlying pre-tax profit for the full year. The group still expects capital expenditure to be around £525m for full year.

Find out more about Morrison shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.